A few centuries ago, people who could read
and write were rare. But now, at least in the capitalist
democracies, practically every adult is literate. In the
absence of widespread literacy, it is hard to imagine how
modern societies could function at all.

There are other forms of illiteracy, though, that are
harder to correct.

Democracies ultimately let voters decide what government
policy should be. Citizens can vote on these
important matters, even if they have no idea what they’re
doing. If enough voters fit that description, democratic
governments are bound to make foolish decisions.

Political scientists have documented that roughly
half of all U.S. citizens do not know that each state has
two senators, and that only a quarter realize that senators
serve six-year terms. It is hard to see how voters can
hold politicians accountable for their performance if
they do not even know who did what for how long.

Valuable as studies of political illiteracy are, they hit
only the tip of the iceberg of public ignorance. The primary
activity of modern governments is to determine
economic policies: which services the government supplies
and which it leaves to private markets; how open
the economy is to foreign trade; what environmental,
consumer, labor, and business regulations to impose.
Even if voters knew our constitutional structure and
their representatives’ voting records by heart, intelligent
policies are unlikely to emerge if the voters are economically
illiterate.

Economic illiteracy does not necessarily translate into
foolish policies. We could imagine that the errors of half
the electorate balance out the errors of the other half. In
the real world, though, such happy coincidences are rare.
The unfortunate reality is that more than half of the
electorate does suffer from economic illiteracy. Indeed,
it is fair to say that an ample majority does not understand
the basics of how economies work.

The problem is not that voters lack doctoral-level
expertise in economics, or that they make an occasional
error. We call someone “literate” even if they misspell a
word every now and then. But most voters lack even an
elementary understanding of economics. They are especially
confused about labor markets, international trade,
and the profit motive; and they tend to cluster around
the same errors—like blaming foreigners and greedy corporations
for all their woes, real and imagined.

One way that the damage of economic illiteracy
might be contained is if voters based their decisions on
the concrete results of economic policies, even if they
didn’t understand how the policies achieved those outcomes.
But that isn’t what seems to happen. Politicians
spend a lot of energy trying to find out what policies voters
want, but comparatively little investigating whether
what voters expect from these policies are accurate.
Indeed, when the media analyze the “results” politicians
have achieved, they usually mean that their proposals
have been enacted, and sidestep the difficult issue of
whether their proposals, once enacted, have worked as
advertised. So how can voters know which policies actually
work?

In sum, while foolish beliefs do not necessarily lead to foolish policies, there is every reason to think they
actually do.

THE INTUITIVENESS OF ECONOMIC ILLITERACY

Before turning to statistical evidence on economic literacy,
let me confess that 15 years ago, I was economically
illiterate myself. Before I began to study economics, I
already had a set of emotionally appealing beliefs about
it. To a large extent, learning about economics consisted
in unlearning what I thought I knew. My easiest heuristic
for understanding economic illiteracy, nowadays, is
simply to recall my unschooled intuitions on economic
issues.

Suppose, for example, that you asked me what I used
to think about “technological unemployment” —the fear
that machines are gradually eliminating the economy’s
demand for human beings. Fifteen years ago, I would
have taken this possibility seriously, just as most Americans
do today. But I do not take it seriously any more.

I will discuss the causes of technological unemployment
in a minute. But the “obvious” remedy—restricting
new technology—was fresh in my mind when I read
Frederic Bastiat’s Economic Sophisms for the first time,
and suddenly realized how misguided I had been about
such matters. Ten years before I picked up Bastiat, at the
age of 8, I had become engrossed in Greek mythology
and learned the legend of Sisyphus, the evildoer forever
condemned to roll a boulder up a hill, only to have it slip
from his grasp every time he neared the pinnacle. This
myth made a light go on in my head when Bastiat suggested
that those who favored restricting new technology
so as to prevent technological unemployment are
Sisyphists:

The avowed object and acknowledged effect of
restrictive measures is to increase the amount of
labor necessary for a given result. Another of its
avowed objects and acknowledged effects is to
raise prices, which means nothing more nor less
than a scarcity of goods. Thus, carried to its
extreme, the policy of restriction is pure
Sisyphism…: infinite labor, without any result.

Reading Bastiat inspired me to delve deeper into economics.
While I was disappointed to find out that few
economists rivaled Bastiat’s flair and wit, they had plenty
of solid arguments—few of which had seemed to me
the least bit obvious. Economics takes mental work.
This isn’t because, as so many critics like to think, economics
requires cramming a recalcitrant reality into
straitjacket models. There’s some of that in economics
(see “Theory Gets a Reality Check” in this issue—Ed.),
but not enough to invalidate the main teachings of economics.
These teachings, however, aren’t intuitively evident;
far from it. Indeed, they require that you make a
deliberate effort to see beyond the immediate consequences
of an action to its long-term and indirect
effects. Bastiat called this “seeing the unseen.”

The more I read about the counterintuitive teachings
of economists, the more I thought these people
were on to something.

How very differently one understands the world
after making an effort to “see the unseen” comes out in
bold relief in the Survey of Americans and Economists
on the Economy. The premise of this fascinating
research, undertaken by the Washington Post, the Henry J.
Kaiser Family Foundation, and the Harvard University
Survey Project, is to ask average Americans (1,510 of
them) and professional economists (250 of them) the
same questions about economic matters, and see how
their answers compare.

At least to me, the natural inference of the divergence
of laymen’s and economists’ opinions is that economic
illiteracy is rampant in the general public. If the
public’s beliefs about math or history sharply diverged
from those of professional mathematicians and historians,
I know which side I would bet on. Is it likely that
people’s untutored intuitions about economics are any
more accurate than their “common sense” about history
or math? The public (consisting of human beings, after
all) is ignorant about many things. For my part, I suggest
that one of them is economics.

IRRATIONAL NATIONALISM

One of the first things that stands out in the survey is the
public’s anti-foreign bias. When they contemplate economic
interaction with foreigners, most people are
unreasonably negative. Thus, the public is very worried
about companies sending jobs overseas, while few economists
take this alleged danger seriously. I hardly find
this surprising, since before I studied economics, the
threat of foreign competition driving us to penury
seemed like a real problem to me, too.

However, the (counterintuitive) principle of comparative
advantage shows that specializing and trading
make sense for all countries involved. If you make
clothes, and then have to face cheaper Chinese imports,
your profits from making clothes will go down; but at the
same time, everyone (even you) can buy cheaper clothes;
plus you can switch to making something more valuable,
like cars, for which you wil l be paid more—by car-buyers
whose lives were improved by the cars you helped
make—than they paid you for clothes. And meanwhile,
millions of formerly impoverished people in China hoist
themselves out of poverty.

The public also worries a great deal about the economic
harm of immigration (“foreigners” taking away“our” jobs), while economists see little cause for concern.
Once again, I have been on both sides of the issue: until
I studied economics, immigration seemed to me at best
a necessary evil. But after you digest the implications of
comparative advantage for the international exchange of
goods, it is only a small step to notice that comparative
advantage applies to the international exchange of labor,
too. A fixed amount of labor can accomplish more if
workers specialize and then trade their services, and this
can often best be accomplished if workers move to
where their specialty is needed.

In the United States, for example, millions of highly
skilled women leave the workforce for years due to the
high cost of child care, even though there are millions of
women in Latin America who would be delighted to
move here to offer child-care services at an affordable
price. If these Latin American women had been born in
the United States, the benefits of letting them become
nannies would be plain to all; but when they are “foreigners,”
the U.S. public’s warning bells go off.

The public’s anti-foreign bias is also at work in more
subtle ways. Many economists, pre-eminently Peter
Bauer, have shown that foreign aid often hurts recipient
countries, because (again, counterintuitively) its main
effect is to allow bad policies to linger by enriching
incompetent (and corrupt) recipient governments. And
virtually no economist thinks that foreign aid is a serious
drain on donor nations, because it is such a tiny percentage
of the budget—in the neighborhood of 1 percent of
the U.S. government’s spending, for example. In stark
contrast, the general public sees foreign aid as a grave
danger for the domestic economy. Whenever foreigners
are part of the equation, the public assumes the worst.

VISIBLE UNEMPLOYMENT; INVISIBLE PROSPERITY

A second major pattern in the public’s economic illiteracy
is that people tend to see job loss as an unmitigated
evil. This is because they focus only on the immediately perceived, very real misfortune of someone losing a job.
But “see the unseen”: when technological progress or
increased specialization causes job losses in one line of
work, labor is freed up for more productive uses. There
is always something else to do. And the more goods an
economy produces, the more a worker can buy with his
wages. The problem is that it’s harder to “see” the more
productive work that, in the future, a newly unemployed
worker might do than it is to empathize with his current,
more visible predicament.

Similarly with the fear of technological unemployment
that I used to share with most people. Economists
point out that if technology posed the threat of making
people economically superfluous, then surely we would
all be unemployed by now. After all, 300 years ago almost
everyone was a farmer, but agricultural technology now
enables one farmer to feed 100 people. Does that mean
that the 99 people fed by the farmer (apart from himself)
are unemployed? Obviously not. They are employed in
other occupations, which have been made possible by
freeing their labor from producing food.

If the unemployment of hand-loom weavers caused
by advances in weaving technology had been stopped in
nineteenth-century England, the Industrial Revolution,
to which most of the world’s billions of people owe their
lives, would never have happened. If the unemployment
of horse breeders caused by the advent of the car had
been prevented in early twentieth-century America, we
would not be able to drive farther than our carriages
could take us, and the streets of our cities would be piled
high with horse manure.

What’s seen is the suffering of those whose jobs are
rendered superfluous by technological change. What’s
unseen are (1) how those workers adapt; (2) how they
require less income to meet the same needs, because
technological improvement raises everyone’s standard
of living; and, most of all, (3) the suffering that never
occurs because of the higher wages technology enables.

CORPORATE GREED

Those who don’t understand economics often ridicule
the economists’ belief in an “invisible hand” as a matter
of ideology or faith; what could be more superstitious?

But economists don’t take the invisible hand literally;
it’s a metaphor explaining that even though most people
in markets may be motivated by greed, under
capitalism, the only way they can pursue their self-interest
is by offering each other things they want to buy
from each other. So in markets, self-serving motives are
transformed into other-serving actions, as if by magic.

However, there really is a matter of faith involved in
the public’s division of opinion with economists over
greedy corporations. But the faith is on the non-economists’
side of the divide. It is the unshakeable conviction
that greed is (always) bad.

This faith is understandable if one forgets—ordoesn’t understand in the first place (as I didn’t)—that
markets give people choices: you can go elsewhere if a
greedy corporation fails to satisfy you, so the best way
for the corporation to pursue self-interest is to be attentive
to your needs. Is it any wonder that greedy corporations
are constantly conducting market research to
figure out what people will buy, while the things government
provides (consider public schools or post offices)
are notoriously customer-unfriendly? KFC wants you to
come back, so it tries to minimize lines and give you
good service. But why should the DMV care if you have
to wait for hours to get a driver’s license? You can’t go to
a competing DMV if you’re dissatisfied.

One survey question from the 1996 study that captures
the public’s misunderstanding of this point asks
why the price of gasoline rose back then. An overwhelming
majority of economists—89 percent—pointed
to the normal operation of supply and demand. An
almost equally lopsided fraction of the public—74 percent—blamed “oil companies trying to increase profits.”
Apparently most people think that prices go up when
businesses suddenly start to feel greedier. Economists, in
contrast, expect businesses
to be greedy year-in, year-out;
but only if supplies have
gone down (or demand has
gone up) can they greedily
increase prices without losing
business to competitors.
An oil company that raised
prices in the absence of a supply shortage would lose customers
to an equally greedy oil company that took
advantage of plentiful supplies to charge less—and
thereby get more customers, and more profit.

But what if the companies collude to raise prices
together? Such cartels are rare because of the constant
pressure each member of the cartel feels to undercut the
others to gain profit for itself. And look at the “unseen”
past conditions that must have occurred for a cartel even
to be conceivable. A group of companies that are in a
position to form a cartel must already have conferred
considerable advantages (low prices, high quality) on
their customers to have rung up so much in sales that
they have a commanding market position. Once they
start trying to act like a cartel, they have a long way to go
before their bad behavior overcompensates for the good
(albeit greedy) behavior that made these companies so big.

What I can’t understand as I look back on my own
anti-corporate-greed days is exactly what I thought corporations
do that is so evil. No corporation ever made
me buy something I didn’t want, nor do corporations
employ anyone who doesn’t want a job.

The survey questions about excessive profits and
executive pay help flesh out the general public’s resentment
of corporate “greed.”

Very few economists see executive compensation as
a drag on economic performance. Quite the opposite:
incentives for corporate executives to make wise management
decisions help markets serve consumers (thereby
making the corporations managed by the executives
profitable). Many non-economists fail to connect performance
and reward. It is hard for them to see what
executives “really contribute.” If they were thinking
about professional athletes or movie stars, they might
see matters differently. But the performance of a corporate
manager isn’t nearly as visible as the exertions of a
point guard.

THE TROUBLE WITH DEMOCRACY

When experts observe the seemingly endless list of
failed economic policies, they often blame an “iron triangle”
of special interests. Under a veneer of democratic
rule, these experts assume, politicians actually tune out
public opinion in favor of helping whichever special
interests give most generously
to their campaigns.

But research on economic
literacy raises doubts
about the power of interest
groups to derail democracy.
The policies economists
deplore—like protection
against globalization (i.e., against foreign trade)—turn
out to be immensely popular with the voters. Why
should we think that politicians fail to listen to the voice
of the people, when heeding the voice of the people is
the usual path to political power in a democracy? I would
suggest that politicians listen all too well, and that as a
result, they heed a host of economically illiterate
demands. Even if a politician is economically literate,
the need to get re-elected encourages him to go along
with economic illiteracy.

But if bad policies exist because of voters’ economic
illiteracy, there may be hope. I used to be among the economically
illiterate myself. If I could be educated, maybe
other voters can be, too. The question is whether they
have the imagination to “see the unseen.”